Q3 Market Review and Outlook
The JSE All Share Index continues to move sideways as it fluctuates within a 10% band, continuing the trend for the last three years. Year to date, the market is down 7%, with Industrials down 13% (led by Naspers down 12%), Financials down 7%, but Resources are up 19% with the assistance of a weaker Rand/Dollar of 15%.
Markets are seriously testing investor patience
After three years of virtually a flat JSE equity market with continued volatility of 10% up and down, investors’ patience is wearing thin. Unfortunately, volatility is implicit in investing and over the long term, this volatility often provides good buying opportunities. However, if one finds it difficult to remain calm in these volatile / low return periods, an investment in a more stable income fund will provide 8% to 9% return, but at the risk of missing higher returns when the market recovers.
Many South Africans have lost patience (understandably) and do not believe the economy will recover. And faith in President Ramaphosa making the meaningful changes necessary to kick start the economy, is waning. But, for investors, the key issue is that most of this pessimism is priced into our market and any recovery will boost markets significantly, in our opinion.
Remember the adage “buy low and sell high”? As the market has taken a breather for the past three years, now is not the time to sell. If anything, re-evaluate your investment strategy to ensure your risks match your desired goals.
The SA economy continues to suffer
A technical recession was recorded due to two consecutive quarter declines in GDP of -2.6% and -0.7% (annualised) in 1Q 2018 and 2Q 2018 respectively. However, when comparing like-on-like quarters, 1Q 2018 on 1Q 2017 and 2Q 2018 on 2Q 2017, GDP grew 0.8% and 0.4% respectively. This is a more appropriate measure as it compares “apples with apples” taking seasonality into account.
Irrespective of which definition you use – technical or otherwise – the economy is under pressure. The Reserve bank has reduced this year’s GDP forecast to a mere 0.7% from 1.5%, and for 2019 to 1.5% from 2%.
The SA economy is in trouble as it struggles from 9 years of Zuma neglect. However, changes are taking place, starting with reducing the bleeding of government parastatals, some necessary policy changes in mining and tourism and the creation of a R400bn infrastructure fund.
Although this is minor in terms of what needs to be done, we expect far more material implementation after the election (May 2019) when Ramaphosa can more confidently ring the changes with more support.
Trying to understand the strong and weak Rand
In one month to the 5th of September, the Rand /Dollar depreciated 17% from 13.2 to 15.4. In the following month, the Rand strengthened 8% to 14.1. This wild swing is mainly due to global market effects as there was a massive exodus from emerging markets, sparked by the Turkey and Argentina financial crises. The Rand is the most liquid (highly traded) emerging market currency, resulting in large emerging market shifts being easily effected through the Rand.
Although the recent weak economic data and continued questions over Land Reform is hurting our global reputation, this was by no means the major reasoning for the Rand’s sharp decline. Other emerging markets are in far worse political and economic situations, such as Turkey, Argentina, Brazil and Russia.
Unfortunately, from a currency standpoint, we are lumped together, but these bouts of risk aversion tend not to last very long. The fundamental fair value of the Rand/Dollar is around 12 based on purchasing power parity. Although it is unlikely that the Rand will strengthen to this level before the election next year, due to the unsavory electioneering noise, we should see the Rand’s recent strength consolidate as a semblance of rationality returns.
However, as the major fundamental driver of the Rand is economic growth and positive political reform, we expect the Rand /Dollar to hover between 13.5 and 14.5 until the election, earmarked for May 2019. Thereafter, only signs of positive progress should drive the Rand firmer.
Global economies and markets are strong
With the US economy growing in excess of 4% and Europe recovering, inflation is rising, leading to an increase in interest rates. Added to this, trade wars are pushing up costs and geopolitical tension with Iran is threatening higher oil prices. All this does not bode well for heavily indebted global economies where minor wage growth is taking place.
Equity markets do not like a rising interest rate environment and inflation. Despite this, the US equities (60% of the global market) are trading 30% to 60% above their four major valuation averages. In addition, the US market has not had a significant correction for the last 10 years, which is unprecedented.
Therefore, currently one needs to be cautious when investing offshore.
Investment Outlook Summary
- The economy should start making a slow recovery and accelerate to 1.9% in 2019 and 2.0% in 2020 per the Reserve Bank, which we believe is conservative.
- A further debt downgrade by rating agencies is unlikely.
- The Rand /Dollar should settle into a trading range of 13.5 to 14.5 until the election, barring any global shocks.
- The SA equity market is likely to mark time until the 2019 election. With Ramaphosa gaining more support, far more meaningful policy changes will be implemented, which should boost confidence and the markets.
- Global markets are our biggest concern. High equity valuations, rising interest rates and escalating costs do not bode well. We recommend taking a cautious and conservative approach over the next year.
